simplify for non-advanced approaches banking organizations the framework of regulatory capital deductions and heightened risk weights for mortgage servicing assets, deferred tax assets arising from temporary differences that an institution could not realize through net operating loss carrybacks, and investments in the capital of unconsolidated financial institutions, resulting in potentially fewer deductions for these items (collectively, the deduction framework simplifications);

simplify for non-advanced approaches banking organizations the recognition and calculation of minority interests that are includable in regulatory capital (the minority interest simplification), resulting in potentially greater recognition of minority interests; and

make certain technical amendments to the capital rules for both non-advanced approaches and advanced approaches banking organizations, including, for banking organizations regulated by the Federal Reserve, the removal of the prior approval requirement for redemptions or repurchases of Common Equity Tier 1 capital unless approval is required by other provisions of the capital rules or other applicable laws or regulations.

The technical amendments will be effective on October 1, 2019, and the deduction framework simplifications and minority interest simplification will be effective on April 1, 2020. The final rule also supersedes the transition rule the agencies adopted in 2017 to allow non-advanced approaches banking organizations to continue to apply the transition treatment in effect in 2017 while the agencies considered the capital simplification proposals.

]]>U.S. Banking Agencies Propose Custody Bank Relief under the Supplementary Leverage Ratiohttps://www.finregreform.com/single-post/2019/04/23/u-s-banking-agencies-propose-custody-bank-relief-under-the-supplementary-leverage-ratio/
Tue, 23 Apr 2019 14:06:30 +0000https://www.finregreform.com/?p=4614Continue Reading…]]>The U.S. banking agencies have proposedallowing custodial banking organizations to exclude certain central bank deposits from the calculation of total leverage exposure, the denominator of the U.S. Basel III supplementary leverage ratio (SLR). The proposal implements Section 402 of the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (EGRRCPA). The three U.S. banking organizations that would benefit from this proposal are BNY Mellon, Northern Trust and State Street.

Scope of Relief

The SLR is the ratio of an advanced approaches banking organization’s tier 1 capital over its total leverage exposure – a non-risk weighted measure of the firm’s assets and off-balance sheet exposures that is meant to serve as a backstop for risk-weighted ratios. Deposits held by a banking organization with another bank, including a central bank, are on-balance sheet assets. As a result, a banking organization’s central bank deposits increase its total leverage exposure, which in turn increases the tier 1 capital that must be held to meet the banking organization’s SLR requirements.

Prior to EGRRCPA, commenters had generally argued for the exclusion of central bank deposits from total leverage exposure, in part to recognize the lack of risk associated with central bank deposits compared to other assets and in part to recognize that the amount of central bank deposits is also a function of client-driven activity. Custody banks, in particular, argued that the inclusion of central bank deposits disproportionately affected them because their business model requires them to maintain a greater amount of central bank deposits than other firms.

Clients of custody banks that maintain fiduciary or custodial and safekeeping accounts (FCS Accounts) for securities at a custody bank typically also maintain cash deposit accounts at the custody bank. These deposit accounts are used to fund investments or to settle or otherwise facilitate transactions executed in the clients’ FCS Accounts. The balances in these deposit accounts may fluctuate significantly within a day or day-to-day, potentially resulting in large outflows (or inflows) if a client funds a large investment or settles a high volume of transactions at once. To manage these fluctuations, a custody bank may, in turn, hold a material portion of its client’s deposit account balances on deposit at central banks, providing liquidity to cover expected outflows. In stressed conditions, a client’s deposit account balances may grow if, for example, the client liquidates securities in its FCS Accounts – leading the custody bank to hold even greater balances on deposit at central banks.

Section 402 of EGRRCPA instructed the U.S. banking agencies to adopt a rule permitting custodial banking organizations to exclude from the total leverage exposure denominator of the SLR the amount of an organization’s qualifying central bank deposits up to the aggregate balance of its clients’ deposit accounts that are “linked to” FCS Accounts.

Definition of “Custodial Banking Organization”

The proposed SLR relief would only apply to “custodial banking organizations,” which the rule would define to mean any depository institution holding company that had an average ratio of assets under custody (AUC) to total consolidated assets, for the four most recent quarters, of at least 30 to 1, as well as any insured or uninsured depository institution subsidiary of such a holding company.[1] A banking organization’s AUC would be as reported on its Form FR Y-15, while total consolidated assets would be as reported on its Form FR Y-9C.

The agencies chose the 30-to-1 ratio as approximately the midpoint between the minimum ratio observed for BNY Mellon, Northern Trust and State Street (52 to 1) and the maximum ratio observed for all other advanced approaches banking organizations (9 to 1) over the period from Q2 2016 to Q3 2018. The threshold is also slightly lower than the minimum ratio observed for BNY Mellon, Northern Trust and State Street between Q1 2004 and Q3 2018.

As the proposed rule is currently drafted, a custodial banking organization that ceases to meet or exceed the minimum 30-to-1 ratio over the four most recent quarters would immediately cease to qualify for the relief and would immediately become subject to a higher total leverage exposure measure. The agencies requested comment on whether a longer delay for the loss of an organization’s status as a custodial banking organization would be appropriate in stressed conditions.

Mechanics of Relief

The proposal would establish a deduction for central bank deposits from a custodial banking organization’s total leverage exposure equal to the lesser of:

the total amount of funds the firm and its consolidated subsidiaries (including foreign subsidiaries[2]) have on deposit at qualifying central banks;[3] and

the total amount of client funds on deposit at the custodial banking organization that are linked to FCS accounts.[4]

A “qualifying central bank” would mean a Federal Reserve Bank, the European Central Bank, and the central bank of any OECD country if (i) the sovereign exposures of the country receive a 0% risk weight under the U.S. Basel III capital rules and (ii) the sovereign debt of the country is not in default and has not been in default during the previous five years.

A deposit account would be “linked to” an FCS Account if (i) the deposit account is provided to a client that maintains an FCS Account with the firm and (ii) the deposit account is used to facilitate the administration of the FCS Account – e.g., if the deposit account holds interest and dividend payments related to or funds the purchase and sale of securities in the FCS Account.

Relationship to Other Requirements

As proposed, for custodial banking organizations that are GSIBs (i.e., BNY Mellon and State Street) and therefore are subject to the Federal Reserve’s total loss-absorbing capacity (TLAC) and long-term debt (LTD) requirements, the exclusion from total leverage exposure for the SLR would also affect the firm’s total leverage exposure for the purposes of calculating its leverage-based external TLAC and eligible LTD ratios because the definition of total leverage exposure under the TLAC rule is the same as under the U.S. Basel III capital rules. The agencies have requested comment on the advantages and disadvantages of this approach versus allowing the total leverage exposure exclusion to apply only to custodial banking organizations’ SLR calculations.

The proposed rule would not alter other leverage calculations, including the tier 1 leverage ratio or total leverage exposure amounts as reported on the FR Y-15, which is used to identify GSIBs and determine firms’ GSIB surcharge amounts.

It remains to be seen how the U.S. banking agencies will reconcile the proposed SLR relief for custodial banking organizations with the earlier proposed recalibration of the enhanced supplementary leverage ratio (eSLR) requirements applicable to U.S. GSIBs and their insured depository institution subsidiaries (see an earlier post on the proposed eSLR relief here). In testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs last year, Federal Reserve Vice Chairman for Supervision Randal K. Quarles stated that the agencies may consider adjusting the calibration of relief under the proposed eSLR rule and the exclusion from total leverage exposure for custodial banking organizations under what was then the bill that became EGRRCPA in order to avoid “double counting” of relief.

[1] A subsidiary depository institution of a custodial banking organization would not be required separately to meet the 30-to-1 ratio of AUC to total consolidated assets. The proposed relief would not apply to stand-alone depository institutions – i.e., depository institutions not controlled by a holding company – that would otherwise satisfy the 30-to-1 ratio of AUC to total consolidated assets, but the agencies are considering extending the relief to such institutions.

[2] A foreign subsidiary’s central bank deposits would be converted to U.S. dollars for purposes of the calculation.

[3] According to the preamble to the proposed rule, the total qualifying central bank deposit amount would be calculated as the average daily balance over the reporting quarter to align with the calculation of the on-balance sheet assets component of total leverage exposure based on an average daily balance. We note that the text of the proposed rule does not make this clear.

[4] The agencies do not expect that the scope of FCS accounts as defined under the rule would deviate materially from the current scope of FCS accounts reported under Schedule RC-T of an insured depository institution’s Call Report.

On October 31, the Federal Reserve proposed a rule to implement Section 401 of the Economic Growth, Regulatory Relief and Consumer Protection Act, tailoring enhanced prudential standards for firms with $100 billion or more in total consolidated assets, and the three U.S. banking agencies proposed corresponding tailoring of their Basel III capital and liquidity rules.

Overall, the proposals would:

for U.S. GSIBs, leave existing requirements virtually unchanged; and

make meaningful changes to requirements applicable to U.S. regional banks that have $100 billion or more but less than $700 billion in total consolidated assets and less than $75 billion in cross-jurisdictional activity and weighted short-term wholesale funding.

Our latest visual memorandum describes the proposed tailored regulatory framework in detail, focusing not only on changes to the enhanced prudential standards and capital and liquidity rules but also on firms’ reporting obligations and the further tailoring proposals that are yet to come – e.g., with respect to resolution planning and capital planning requirements.

]]>Federal Banking Agencies Relax LCR Treatment of Municipal Bonds in Line with EGRRCPAhttps://www.finregreform.com/single-post/2018/08/23/federal-banking-agencies-relax-lcr-treatment-municipal-bonds-line-egrrcpa/
Thu, 23 Aug 2018 20:47:18 +0000https://www.finregreform.com/?p=3977Continue Reading…]]>The three Federal banking agencies jointly released an interim final rule on August 22, 2018 that amends the agencies’ respective liquidity coverage ratio (LCR) rules to treat as level 2B high-quality liquid assets (HQLAs) any municipal obligation that is both (1) “liquid and readily marketable” and (2) “investment grade.” The amendment implements Section 403 of the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (the EGRRCPA). Our visual memorandum on the EGRRCPA is available here. Because the amendment implements regulatory changes mandated by a statute, the agencies have determined that a notice of proposed rulemaking procedure is unnecessary. The interim final rule will become effective immediately upon publication to the Federal Register, which is expected in the coming days or weeks, although the agencies still request comment on any aspect of the rule.

Prior to the interim final rule, the Federal Reserve’s LCR rule permitted only a subset of municipal obligations—those meeting the definition of “general obligation” municipal securities and meeting certain heightened criteria—to be recognized as HQLAs, pursuant to a 2016 amendment to the Federal Reserve’s LCR rule. Even these eligible municipal obligations were subject to additional quantitative limitations, including an aggregate limit on the amount of eligible municipal obligations recognizable in a banking organization’s total HQLA amount. The OCC’s and FDIC’s LCR rules did not permit any municipal obligations to be recognized as HQLAs.

The interim final rule aligns the three agencies’ rules to a common standard that both expands the eligibility criteria and removes the municipal obligation-specific quantitative limitations under the existing Federal Reserve rule, as follows:

Expanded Eligibility Criteria – General Obligations vs. Revenue Bonds: The interim final rule defines a municipal obligation as an obligation of a state or any political subdivision thereof or of any agency or instrumentality of a state or any political subdivision thereof. This definition is broader than the existing Federal Reserve criterion that restricts HQLA treatment to “general obligations,” which are defined as bonds or similar obligations that are backed by the full faith and credit of a state, local authority or other governmental subdivision below the U.S. sovereign entity level (each a type of “public-sector entity”). The interim final rule effectively permits so-called “revenue bonds”—i.e., obligations of an agency or instrumentality of a state or municipality that are typically supported by revenues from a particular public-works project, such as a toll road—to be recognized as HQLAs for the first time.

Expanded Eligibility Criteria – Liquidity Criterion and Financial Sector Entity Exclusion: The interim final rule eliminates two additional eligibility criteria for municipal obligations that were present in the Federal Reserve’s LCR rule, and replaces them with the more straightforward criteria that the eligible municipal obligations be both “liquid and readily marketable” and “investment grade.”

First, the interim final rule eliminates the Federal Reserve requirement that eligible municipal obligations must be issued or guaranteed by public-sector entity “whose obligations have a proven record as a reliable source of liquidity in repurchase or sales markets during stress conditions.”

Second, the interim final rule also eliminates the Federal Reserve requirement that eligible municipal obligations must not be an obligation of a “financial sector entity” (or a consolidated subsidiary thereof), a broad term that includes pension funds, investment companies, non-regulated funds, and investment advisors.

In lieu of these criteria, the interim final rule requires only that the municipal obligations be (1) “liquid and readily-marketable” (a criterion for recognizing virtually any asset as an HQLA, other than certain categories of assets that are presumptively liquid, such as Treasury securities) and (2) “investment grade.” Consistent with the EGRRCPA, the investment grade criterion for municipal obligations incorporates by reference the definition of “investment grade” used in the OCC’s investment securities regulations and elsewhere, meaning that the issuer has “an adequate capacity to meet financial commitments under the security for the projected life of the asset or exposure,” which is met if “the risk of default by the obligor is low and the full and timely repayment of principal and interest is expected.” See 12 C.F.R. § 1.2.

Termination of Quantitative Limits: The interim final rule eliminates two additional quantitative limits imposed by the Federal Reserve’s LCR rule on the recognition of eligible municipal obligations as level 2B HQLAs.

First, the aggregate amount of eligible municipal obligations recognizable in a banking organization’s level 2B HQLA amount will no longer be limited to 5 percent of the banking organization’s total HQLA amount.

Second, the interim final rule also eliminates the concentration-based limitation, which caps the amount of securities issued by a single public sector entity that a firm may recognize in HQLAs.

Eligible municipal obligations are still subject to the limits, restrictions and other criteria generally applicable to level 2B HQLAs, including the 50 percent haircut applied to their fair value and the aggregate level 2B HQLA limit of 15 percent of a banking organization’s total HQLA amount.

The interim final rule is applicable to all banking organizations subject to the LCR rule, including those subject to the less stringent “modified LCR” requirement under the Federal Reserve’s LCR rule.

]]>Basel Committee Publishes Revised Assessment Methodology for GSIBshttps://www.finregreform.com/single-post/2018/07/10/basel-committee-publishes-revised-assessment-methodology-gsibs/
Tue, 10 Jul 2018 20:55:52 +0000https://www.finregreform.com/?p=3866Continue Reading…]]>The Basel Committee on Banking Supervision last week published a revised assessment methodology to determine whether a banking organization is a global systemically important bank (“GSIB”) and a GSIB’s associated capital surcharge requirement. The revised methodology reflects the following changes from the current methodology, which are expected to be implemented in member jurisdictions by January 2021 and to determine the GSIBs’ applicable capital surcharge requirements from January 2023:

Revisions to the substitutability category, including a new trading volume indicator;

Expansion of the scope of consolidation to include insurance activities for certain systemic indicators;

Amendments to the definition of cross-jurisdictional indicators;

Guidance on a firm’s migrationfrom a higher GSIB surcharge bucket to a lower GSIB surcharge bucket; and

Revisions to the disclosure requirements relating to restatements of prior-year data.

In the United States, the Basel Committee’s methodology is incorporated into the GSIB surcharge framework of the Federal Reserve’s capital rules as Method 1. Unlike the Basel Committee, the Federal Reserve adopted a second, alternative methodology, known as Method 2, which replaces the substitutability category with a short-term wholesale funding category, is calibrated so that it produces scores higher than Method 1, and is designed to be more of a fixed and less of a relative measure of systemic importance. Because Method 2 is the binding constraint in determining U.S. GSIB scores, and thus their GSIB surcharge requirements, it is unclear whether the changes in the Basel Committee’s methodology would have a material impact on U.S. GSIBs unless the Federal Reserve, in proposing how to implement these changes, revisits Method 2 and its calibration as well.

Revisions to the Substitutability Category

The revised methodology introduces a new indicator for trading volume in the substitutability category. Although the Basel Committee did not disclose the details of how it will measure the new indicator, the 2017 consultation document suggests that this indicator will be based on two equally weighted measures of relative annual trading volume in (1) certain fixed income securities (excluding sovereign debt instruments) and (2) equity and other securities. The new trading volume indicator will receive a weighting of 3.33%, and the weighting for the existing indicator for underwritten transactions in debt and equity will be reduced to 3.33% (from 6.67% under the current methodology), as shown in the table below.

Current Methodology

Revised Methodology

Indicator

Weighting

Indicator

Weighting

Assets Under Custody

6.67%

Assets Under Custody

6.67%

Payments Activity

6.67%

Payments Activity

6.67%

Underwritten Transactions in Debt and Equity

6.67%

Underwritten Transactions in Debt and Equity

3.33%

Trading Volume

3.33%

The trading volume indicator is meant to reflect the systemic importance of a firm’s facilitation of market liquidity through market making and agency-based trading activities. The trading volume indicator is distinguished from the underwriting indicator (which is also part of the substitutability category) as the former reflects activity in the secondary markets, whereas the latter reflects activity in primary markets for debt and equity instruments. According to the 2017 consultation document, the trading volume indicator is meant to complement the indicators for trading and available-for-sale securities and OTC derivatives under the complexity category, by providing a “flow” measure of trading activity (presumably a reference to a measurement of trading activity over a period of time), as opposed to a “stock,” period-end balance sheet measure.

The revised methodology retains for at least the next three years the existing cap on the substitutability category, which limits the unweighted, combined contribution of the substitutability indicators to 500 basis points (100 basis points on a weighted basis). This approach reflects a shift from the 2017 consultative document, which would have entirely removed the cap on the substitutability category score. The Basel Committee explained, however, that the continued existence of the substitutability cap is intended to be a temporary solution. At the time of the next triennial review of the framework in 2021, it will seek “alternative methodologies for the substitutability category, so as to allow the cap to be removed at that time.”

Expanded Scope of Consolidation for Insurance Activities

The revised methodology expands the scope of consolidation for purposes of certain systemic indicators to include exposures and activities of insurance subsidiaries. Under the current methodology, insurance subsidiaries of banking groups are excluded from the scope of consolidation for the purposes of all of the systemic indicator calculations. The expanded scope of consolidation for insurance activities applies to the following systemic indicators:

The revised methodology modifies the definition of the two systemic indicators for cross-jurisdictional activity—cross-jurisdictional claims and cross-jurisdictional liabilities—generally to harmonize them with recently revised related terms used in the Bank for International Settlements’ consolidated statistical reporting metrics on the global banking system. Although the precise definitions are not yet published, according to the 2017 consultation document, the revised definitions would have the effect of including both derivatives assets and liabilities in the cross-jurisdictional claims and liabilities, respectively. Under the current methodology, derivatives assets and liabilities are excluded from the cross-jurisdictional indicators, primarily due to legacy issues with data collection and the inconsistency between reporting derivatives assets on a consolidated basis and derivatives liabilities at a legal entity (branch and subsidiary) level.

Surcharge Bucket Migration

The revised methodology provides new guidance that, if a firm’s new GSIB score for a particular year falls in a lower GSIB surcharge bucket than in the prior year, the change should immediately result in a lower GSIB surcharge, whereas a move to a higher GSIB surcharge bucket should take effect after a lag of 12 months (as under the current methodology). This is consistent with how the effectiveness of changes in a firm’s GSIB surcharge has been implemented in the United States.[1]

Disclosure Requirements for Restatements

The revised methodology provides new guidance that national authorities should require firms to publicly disclose whether data used to calculate GSIB scores differ from those previously disclosed. Firms affected by such a restatement should disclose the revised data in the financial quarter immediately following the finalization of the GSIB score calculation.

Effective Date

The effective date for the Basel Committee’s revised GSIB assessment methodology is the 2021 annual calculation cycle, for which year-end 2020 data will be used. An updated list of GSIBs based on the new methodology will be published in November 2021, with GSIB surcharges resulting from the methodology becoming effective January 1, 2023.

]]>Federal Reserve Releases 2018 CCAR Resultshttps://www.finregreform.com/single-post/2018/07/03/federal-reserve-releases-2018-ccar-results/
Tue, 03 Jul 2018 16:32:39 +0000https://www.finregreform.com/?p=3819Continue Reading…]]>The Federal Reserve last week released the results of its 2018 Comprehensive Capital Analysis and Review (CCAR). We have analyzed the 2018 CCAR results, along with the Dodd-Frank Act Stress Test results published the previous week, and have prepared a graphical summary available here. As our summary shows, on average the stress losses for the firms subject to CCAR in 2018—measured by impact on CET1 risk-based capital ratios—were 33% higher compared to the 2017 CCAR cycle, evidence of the increased severity of the Federal Reserve’s severely adverse supervisory stress scenario.

A total of 35 firms were subject to the 2018 CCAR assessments: 13 advanced approaches U.S. bank holding companies (BHCs), 10 non-advanced approaches U.S. BHCs, and 12 U.S. intermediate holding companies (IHCs) of foreign banking organizations. For the first time, U.S. BHCs with $50 billion or more but less than $100 billion in total consolidated assets were excluded from the CCAR assessment, consistent with the statutory change in the threshold for enhanced prudential standards under the Economic Growth, Regulatory Relief, and Consumer Protection Act enacted in May of this year. This change excluded three BHCs—CIT Group, Comerica and Zions—from this year’s assessment.

The Federal Reserve did not object to the capital plans of 34 of the 35 firms. The Federal Reserve objected to one firm’s capital plan on qualitative grounds and issued a conditional non-objection on quantitative grounds for three firms—Goldman Sachs, Morgan Stanley and State Street. For Goldman Sachs and Morgan Stanley, the Federal Reserve announced that it would not object to each firm’s planned capital distributions so long as they are limited to no more than a benchmark amount equal to the greater of the firm’s actual distributions made over the previous four calendar quarters and the annualized average of actual distributions over the previous eight calendar quarters. For State Street, the Federal Reserve stated that it has required the firm to take certain steps regarding the management and analysis of its counterparty exposures under stress. Four other firms—American Express, JPMorgan, KeyCorp and M&T Bank—took advantage of the opportunity to adjust their planned capital actions (the so-called “mulligan”) after receiving the Federal Reserve’s preliminary estimates for their post-stress capital ratios.

The Federal Reserve noted that each of the three firms receiving a conditional non-objection was projected to have at least one minimum post-stress capital ratio lower than the corresponding minimum required capital ratio, attributable in part to the adverse one-time accounting impacts of the Tax Cuts and Jobs Act (TCJA) enacted in December 2017. The Federal Reserve cited, among other factors, the one-time negative impact on these firms’ capital ratios stemming from an overall favorable tax change, which the Federal Reserve noted was not indicative of the firms’ performances under stress, as well as “uncertainties” in firms’ capital ratios resulting from the timing of the TCJA—likely a reference to the timing of deferred tax assets and deferred tax liabilities. The conditions to the Federal Reserve’s non-objections for Goldman Sachs and Morgan Stanley effectively limit these firms’ capital distributions for the next four quarters based on a backward-looking benchmark, an approach consistent with the limitations imposed in past cycles for firms that did not meet post-stress minimum requirements and received quantitative objections (see, e.g., the limitations imposed on Zions in the 2014 CCAR cycle). We also note that five out of the six capital shortfalls (two for each of the three firms) related to Tier 1 leverage or supplementary leverage ratios, suggesting potential structural or conceptual inconsistencies with the use of risk-insensitive capital measures, which are intended as back-stops to the primary risk-based capital requirements, as post-stress minimum requirements.

The Federal Reserve also publicly identified the following three trends it observed in the capital planning practices of the 35 CCAR firms:

For certain areas, such as credit cards, auto loans and revenues from certain business lines, the Federal Reserve noted certain inherent difficulties, such as lack of relevant data, in estimating stress losses or revenues. The Federal Reserve noted that some firms more than others were able to use “appropriate techniques” to overcome these challenges, although it did not publicly elaborate on the nature of the difficulties or its preferred techniques to address them.

The Federal Reserve observed that some firms had “purchased large trading positions to offset the losses arising from the instantaneous market shock,” which we presume is a reference to the global market shock (GMS) scenario component to which six of the largest CCAR firms are subject. The Federal Reserve noted that this practice could be cause for concern if firms have not sufficiently analyzed the risk of these hedging strategies and subjected them to appropriate governance procedures. As an example of the type of risks from these strategies, the Federal Reserve pointed to the possibility that counterparties could be unwilling to make such hedging positions available during periods of market stress.

The Federal Reserve also observed that many firms’ internal controls for capital planning fall short of supervisory expectations in various areas, including information systems and data management, capital planning audits, and model risk management.

About CCAR

CCAR is the Federal Reserve’s annual assessment of the capital planning processes of the largest U.S. BHCs – those with more than $100 billion in total consolidated assets – and the U.S. IHCs of foreign banking organizations. CCAR includes a quantitative assessment under stressed conditions, which measures, over a forward-looking nine-quarter time horizon, whether the firm would meet minimum capital requirements (without capital buffers) under a hypothetical adverse and severely adverse economic scenarios assuming the implementation of the firm’s proposed capital action plan (i.e., its planned dividends, share buybacks and capital-raising actions over the nine-quarter horizon). In addition, CCAR includes for the 18 largest and most complex firms a qualitative assessment of the firm’s capital planning processes and management. If the Federal Reserve objects to a firm’s capital plan on either a quantitative or (if applicable) qualitative basis, the firm will not be permitted to distribute capital through dividends, share repurchases or other means, except as specifically approved by the Federal Reserve.

]]>Federal Reserve and OCC Propose Tailoring of Enhanced Supplementary Leverage Ratios for GSIBs and their IDIshttps://www.finregreform.com/single-post/2018/04/17/federal-reserve-occ-propose-tailoring-enhanced-supplementary-leverage-ratios-gsibs-idis/
Wed, 18 Apr 2018 02:43:24 +0000https://www.finregreform.com/?p=3541Continue Reading…]]>The Federal Reserve and the OCC have proposed a rule that would recalibrate the enhanced supplementary leverage ratio (eSLR) requirements applicable to U.S. GSIBs and their insured depository institution (IDI) subsidiaries, and related requirements, by tailoring the eSLR levels to 50 percent of each firm’s GSIB surcharge. The proposal would make the eSLR requirements and related total loss absorbing capacity (TLAC) requirements for GSIB holding companies and the well-capitalized Prompt Corrective Action (PCA) framework for their IDI subsidiaries firm-specific and dynamic by tying them to a firm’s GSIB surcharge as calculated periodically under the Federal Reserve’s Basel III capital rule.

The proposal would only affect U.S. GSIBs and their IDI subsidiaries. Based on current GSIB surcharge levels, the proposal would reduce the eSLR and related requirements, particularly for IDI subsidiaries, reinforcing the status of the supplementary leverage ratio (SLR) as a backstop to the institutions’ applicable risk-based capital requirements.

The proposal does not specify a proposed effective date.

Recalibrated eSLR Buffer Requirement for GSIB BHCs

The eSLR Tailoring Proposal would recalibrate the uniform, static 2.0% eSLR requirement, applicable to the top-level BHC of a GSIB on a consolidated basis, with a firm-specific, dynamic buffer requirement calibrated at 50% of the firm’s risk-based GSIB surcharge. For example, a BHC firm with a GSIB surcharge of 3.0% would face a tailored eSLR requirement of 1.5%, down from the 2.0% eSLR requirement currently applicable to all BHCs.

Revised Well-Capitalized Standard for IDI Subsidiaries of GSIBs

The eSLR Tailoring Proposal would also recalibrate the current well-capitalized SLR standard under the PCA framework applicable to Federal Reserve- and OCC-supervised IDI subsidiaries of GSIBs. (There are currently no significant IDI subsidiaries of GSIBs for which the primary federal banking supervisor is the FDIC.) Specifically, it would change the well-capitalized standard from the uniform, static level of 6.0% to a firm-specific, dynamic level equal to the sum of (i) 3.0% and (ii) 50% of the GSIB surcharge applicable to the IDI’s top-tier parent BHC. For example, for a firm with a GSIB surcharge of 3.0% and an OCC-supervised national bank subsidiary, the national bank would be required to maintain an SLR of 5.5%, rather than 6.0%, to be considered well capitalized under OCC regulations. The well-capitalized standard is used for several regulatory purposes and has important knock-on effects, especially for BHCs that have elected to become financial holding companies (FHCs), as is the case with all eight U.S. GSIBs. FHCs and their IDI subsidiaries are required to be well capitalized and well managed to avoid restrictions or limitations on activities requiring FHC authority under the Bank Holding Company Act of 1956.

Corresponding Changes to TLAC

Finally, the eSLR Tailoring Proposal would make corresponding changes to the calibration of the TLAC leverage-based requirements applicable to GSIBs, as well as certain other technical changes to the TLAC rule. Specifically, the proposal would make the following substantive changes to the TLAC rule:

TLAC SLR Buffer. Recalibrate the current TLAC SLR buffer requirement for GSIBs (currently 2% of total leverage exposures) with a buffer requirement equal to 50% of the firm’s GSIB surcharge (equivalent to the proposed recalibration of the eSLR buffer requirement discussed above).

LTD SLR Minimum. Recalibrate the current LTD SLR minimum requirement for GSIBs (currently 4.5% of total leverage exposures) with a minimum requirement equal to the sum of (i) 2.5% and (ii) 50% of the firm’s GSIB surcharge.

Actual Buffer Amount Formulas. Eliminate an existing discrepancy between the actual TLAC amount used in determining compliance with the minimum TLAC requirements and the formulas for measuring a firm’s applicable external TLAC buffer amount (including the risk-weighted and SLR buffers for GSIBs), which are used to determine compliance with the related TLAC buffer requirements, by amending the formulas for the buffer amount so that they add back 50% of the unpaid principal amount of outstanding LTD maturing between one and two years.

Requests for Comment

The SLR Tailoring Proposal includes several requests for comment, including three that we find particularly noteworthy:

eSLR as Buffer for IDIs. The agencies requested comment on whether it would be more appropriate to apply the eSLR requirement to an IDI subsidiary of a GSIB as a capital buffer, in the same way as the eSLR requirement applies to GSIB BHCs, rather than as a requirement to be well capitalized.

SLR Denominator. The agencies requested comments on alternative approaches to addressing the degree to which the SLR can act as a binding capital constraint, rather than as a backstop to the risk-based capital requirements. Specifically, the agencies asked about the possibility of excluding central bank reserves from the denominator of the SLR. Such a change would presumably apply to all banking organizations subject to the SLR (i.e., all advanced approaches banking organizations), not just GSIBs. This change would also go farther than the Senate Banking Bill, which would create a similar but more limited exclusion only for custody banks. In testimony before the House Financial Services Committee on April 17, 2018, Federal Reserve Vice Chair Randal Quarles noted that if the Senate Banking bill becomes law, the Federal Reserve and the OCC would have to consider how to calibrate the eSLR Tailoring Proposal so that the changes made by it and the Senate Banking Bill work together.

TLAC SLR Minimum Requirement. The agencies also requested comment on the calibration of the TLAC SLR minimum requirement, asking whether the Federal Reserve should “modify the requirement … that a GSIB maintain an external loss-absorbing capacity amount that is no less than 7.5 percent of the GSIB’s total leverage exposure.” The invitation for comment on suggested modifications to the existing 7.5% minimum requirement—which is gold plated relative to the international standard—specifically asks whether the requirement should be modified to “better align… with similar foreign or international standards or expectations.”

]]>Federal Reserve Proposes Stress Capital Buffer Requirements in Overhaul of CCARhttps://www.finregreform.com/single-post/2018/04/17/federal-reserve-proposes-stress-capital-buffer-requirements-overhaul-ccar/
Wed, 18 Apr 2018 01:43:09 +0000https://www.finregreform.com/?p=3533Continue Reading…]]>The Stress Buffer Requirements (SBR) Proposalwould fundamentally restructure how the Federal Reserve’s stress testing and capital planning framework is used to impose capital requirements for large banking organizations. In general, the proposal would shift the quantitative capital requirements based on a firm’s pro forma stress losses, which currently are calculated and used only for purposes of the Federal Reserve’s Comprehensive Capital Adequacy Review (CCAR), into two new capital buffer requirements known as the stress buffer requirements.

The SBR Proposal would apply to BHCs with $50 billion or more in total consolidated assets, the U.S. intermediate holding companies of foreign banking organizations, and any nonbank systemically important financial institutions subject to supervisory stress testing (of which there are currently none). For the reasons explained below, U.S. global systemically important banking organizations (GSIBs) would be most affected by the SBR Proposal.

Proposed Stress Buffer Requirements

Under the SBR Proposal, the forward-looking supervisory stress test results calculated by the Federal Reserve once per year for the covered banking organizations would be integrated into these firms’ point-in-time capital requirements, which they must maintain throughout the year in order to avoid limitations on capital distributions and discretionary bonus payments. The stress buffer requirements include a stress capital buffer (SCB) requirement and a stress leverage buffer (SLB) requirement. Specifically, the stress buffer requirements would be calibrated to equal:

thepeak-to-trough decrease over the nine-quarter stress testing horizon in a firm’s standardized approach CET1 risk-based capital ratio (for the SCB) and in its tier 1 leverage ratio (for the SLB), in each case as determined under the severely adverse scenario of the Federal Reserve’s annual supervisory stress test; plus

planned dividends over the fourth through seventh quarters of the planning horizon as a percentage of risk-weighted assets (for the SCB) or the denominator of the tier 1 leverage ratio (for the SLB).

The peak-to-trough decrease is measured by the difference between the starting level of the relevant capital ratio and the lowest level of that ratio under the severely adverse scenario in any of the nine quarters covered by the supervisory stress test. In the case of the SCB, the calibration would be the greater of (1) the peak-to-trough decrease in the firm’s CET1 risk-based capital ratio plus the applicable four quarters of planned dividends as a percentage of risk-weighted assets and (2) 2.5%. The resulting stress buffer requirements would be firm-specific and recalibrated annually based on the supervisory stress test.

1. The SCB Requirement

The SCB requirement would replace, for purposes of a firm’s capital requirements under the standardized approach, the static 2.5% capital conservation buffer requirement, but would not replace the GSIB surcharge or countercyclical buffer. As a result, the total standardized approach buffer requirement for a GSIB would equal the sum of:

the stress capital buffer,

the GSIB surcharge, and

the countercyclical buffer (if deployed).

On a post-stress basis, a firm would be required to meet not only its minimum capital requirements to be adequately capitalized (i.e., a 4.5% CET1 risk-based capital ratio), but also the full amount of its GSIB surcharge to avoid any restrictions on capital distributions and discretionary bonus payments. This change is significant because a firm is currently required to have enough capital to absorb its peak-to-trough stress losses plus its planned capital distributions and meet its minimum capital requirements to be adequately capitalized (i.e., a 4.5% CET1 risk-based capital ratio) on a post-stress basis without needing to meet its GSIB surcharge.

The following graphic illustrates the aggregate standardized approach CET1 risk-based capital requirements under the SBR Proposal for a GSIB on a point-in-time basis, pursuant to the Federal Reserve’s capital rules, to avoid any restrictions on capital distributions or discretionary bonus payments.

For purposes of the advanced approaches, the buffer requirements would continue to consist of the current 2.5% static capital conservation buffer plus any applicable GSIB surcharge and any countercyclical buffer. This is consistent with the Federal Reserve’s existing approach of not using the advanced approaches to determine stress losses under CCAR.

2. The SLB Requirement

The SLB requirement would not replace any existing buffer requirement in the point-in-time capital and leverage framework. As with the risk-based capital buffers, a firm would have to maintain the full amount of its SLB requirement on top of its 4% minimum required tier 1 leverage ratio in order to avoid limitations on capital distributions and discretionary bonus payments. Although this point-in-time leverage buffer requirement is new, it is consistent with the Federal Reserve’s current practice of evaluating a firm’s post-stress tier 1 leverage ratio under the existing quantitative CCAR requirements. There is no SLR component to the SLB requirement.

The following graphic illustrates the aggregate tier 1 leverage requirements under the SBR Proposal for a GSIB on a point-in-time basis, pursuant to the Federal Reserve’s capital rules, to avoid any restrictions on capital distributions or discretionary bonus payments.

Proposed Changes to Stress Testing and Capital Planning Assumptions

In addition to these structural changes, the SBR Proposal would also simultaneously relax certain assumptions related to the determination of a firm’s pro forma stress losses and its planned capital distributions for purposes of its capital plan in CCAR. These relaxed assumptions would have the effect of reducing the effective buffer that firms must maintain to “pre-capitalize” their planned capital distributions in their capital plans. They would also have the effect of eliminating the assumption of balance sheet growth over the stress testing horizon that is part of the current CCAR framework.

Specifically, in CCAR each firm would be required to assume its planned capital distributions for the fourth through seventh quarters of the planning horizon (corresponding to the one-year period beginning October 1 of the year of the capital planning cycle, coinciding with the effective date of its stress buffer requirements for the following one-year period) at a level consistent with any restrictions on capital distributions that would apply under the firm’s own baseline scenario projections.1 In addition, the firm would no longer be required to assume that it would continue share repurchases.

In view of the fact that the level of planned capital distributions would be based on a firm’s ownbaseline scenario and projections, the Federal Reserve has indicated that it intends to conduct periodic back-testing of these projections against realized results. If a firm’s realized results reflect a “pattern of materially underperforming baseline projections for earnings, capital levels or capital ratios,” the Federal Reserve may interpret such systematic underperformance as indicative of weakness in the firm’s capital planning and subject the firm to heightened scrutiny under any qualitative supervisory assessment of its capital planning processes.

The following graphic illustrates the proposed change in the amount of capital required to avoid limitations on capital distributions on a post-stress basis under CCAR.

Effect on CCAR

CCAR would remain under the SBR Proposal, but it would no longer be the primary mechanism for ensuring that large banking organizations maintain sufficient capital to continue operations through times of economic and financial stress. Instead, CCAR would be refocused to serve the purpose of estimating the firms’ stress losses and thereby determining the level of their SCB and SLB requirements. Under the proposal, the Federal Reserve would no longer be able to issue a quantitative objection to a firm’s capital plan, relying instead on the restrictions on capital distributions and discretionary bonus payments that apply under the capital rules if a firm fails to meet its full capital buffer requirements. However, the Federal Reserve would still be able to issue a qualitative objection for large and complex firms (generally, all GSIBs and all other BHCs with $250 billion or more in total consolidated assets or $75 billion or more in nonbank assets) and firms would continue to be required to describe their planned capital actions under CCAR and not exceed these planned distributions during the following year.

Effective Date, Timing and Procedural Considerations

The SBR Proposal would be effective on December 31, 2018, in time for the 2019 stress testing and capital planning cycle. Under the SBR Proposal’s timeline for stress testing and capital planning cycles, each firm’s stress buffer requirements would generally be released by the Federal Reserve by June 30 of the year of the cycle, take effect on October 1 of the same year and continue in effect until September 30 of the following year. We note that this one-year effective period for the annual stress buffer requirements matches the fourth through seventh quarters of the planning horizon under CCAR. Under this timeline, the first stress buffer requirements would become effective on October 1, 2019.

The SBR Proposal would revise or update several procedural considerations embedded in the existing CCAR process. Consistent with existing quantitative CCAR requirements, firms would have a one-time “mulligan” each cycle to resubmit planned capital actions within two business days of receiving an initial notice of its stress buffer requirements. This procedural safeguard allows a firm an opportunity to curtail planned distributions, if necessary to avoid any distribution limitations that would apply on a pro forma basis under its own baseline scenario projections. In addition, firms would be permitted to request a reconsideration of the calibration of either of its stress buffer requirements, triggering a requirement that the Federal Reserve respond in writing within 30 days, and would also be permitted to request a reconsideration of any qualitative objection to its capital plan.

Finally, among its numerous requests for comment on the SBR Proposal, the Federal Reserve specifically raised the possibility that the severely adverse scenario used for CCAR and stress testing purposes would be published for notice and comment. If adopted, this change would effectively allow firms to provide feedback to the Federal Reserve about the potential impact of the severely adverse scenario on their capital plans prior to the finalization of the annual CCAR instructions, and would clearly increase the transparency of the CCAR and stress testing framework.

1 These restrictions are determined by the most restrictive of the following requirements: (1) all standardized approach buffer requirements, including the SCB, (2) the SLB, (3) the eSLR (if applicable) and (4) the firm’s advanced approaches capital conservation buffer requirement (if applicable).

]]>Visual Memorandum: Senate Bipartisan Banking Bill to Rebalance the Financial Regulatory Landscapehttps://www.finregreform.com/single-post/2018/03/28/visual-memorandum-senate-bipartisan-banking-bill-rebalance-financial-regulatory-landscape/
Wed, 28 Mar 2018 18:27:30 +0000https://www.finregreform.com/?p=3472Continue Reading…]]>The Senate passed the Economic Growth, Regulatory Relief and Consumer Protection Act (S.2155) on March 14 by a filibuster-proof vote of 67 – 31. The Senate bill still must pass the House, where Rep. Jeb Hensarling (R-TX) and other representatives have said they plan to propose a series of amendments to the bill. Today, we published a visual memorandum here summarizing the most material provisions of the Senate bill affecting the regulation of banking organizations.

Law Clerk Greg Swanson contributed to this post.

]]>Senate Bipartisan Banking Bill Offers Relief from Stress Testing, Capital and Liquidity Requirementshttps://www.finregreform.com/single-post/2018/03/16/senate-bipartisan-banking-bill-offers-relief-stress-testing-capital-liquidity-requirements/
Fri, 16 Mar 2018 15:05:09 +0000https://www.finregreform.com/?p=3411Continue Reading…]]>The Bipartisan Banking Bill would provide banking organizations with relief from their stress testing, capital and liquidity requirements by adjusting the thresholds, frequency and substance of these rules. The bill – which recently passed in the Senate, as described in a recent post here – is now being considered in the House, where Rep. Jeb Hensarling (R-TX) and other representatives have said they plan to propose a series of amendments.

This post summarizes how the Bipartisan Banking Bill would change the U.S. banking agencies’ stress testing, capital and liquidity rules – including by adding a new and unusual statutory override of the U.S. banking agencies’ Basel III capital rules for higher-risk commercial real estate exposures that was not included in earlier versions of the bill.

We have also published a visual memorandum here that goes into more detail on these and other elements of the bill.

Changes Surviving from Earlier Drafts of the Bill

As passed by the Senate, the Bipartisan Banking Bill preserves most of the changes that earlier versions of the bill would have made to the stress testing, capital and liquidity rules – as discussed in our previous posts here, here and here. These changes include the following:

Supplementary Leverage Ratio (SLR) for Custody Banks. The bill would direct the U.S. banking agencies to exclude certain central bank deposits from the total leverage exposure (the SLR denominator) of a custody bank—defined as a “depository institution holding company predominantly engaged in custody, safekeeping and asset servicing activities,” together with its insured depository institution subsidiaries. Central bank reserves of a custody bank would be excluded only to the extent of the value of client deposits at the custody bank that are linked to fiduciary, custody or safekeeping accounts.

The bill does not specifically define “predominantly engaged.”

The bill specifically includes a rule of construction that nothing in this provision would limit the U.S. banking agencies’ authority to tailor or adjust the SLR or any other leverage ratio for any bank that is not a custody bank.

Treatment of Municipal Securities under the Liquidity Coverage Ratio (LCR). The U.S. banking agencies would be required to consider certain investment grade municipal securities as Level 2B high quality liquid assets for purposes of the LCR. These proposed changes to the LCR are consistent with H.R. 1624, which passed the House on October 3, as discussed in an earlier post here.

Thresholds and Frequency of Dodd-Frank Act Company-Run Stress Tests. The statutory thresholds for Dodd-Frank Act company-run stress tests for BHCs would increase to $250 billion from their current levels—more than $10 billion for annual company-run stress tests and $50 billion or more for mid-year company-run stress tests. In addition, the bill would eliminate the statutory requirement that company-run stress tests be conducted at an annual or semi-annual frequency, depending on the size of the company—adopting instead a more flexible standard of “periodic” stress tests.

Thresholds and Frequency of Dodd-Frank Act Supervisory Stress Tests. For BHCs with total consolidated assets of $100 billion or more and less than $250 billion, the Federal Reserve would be required to conduct “periodic,” rather than annual, supervisory stress tests. We note that this requirement is in Section 401(e) of the Bipartisan Senate Bill and does not also appear in the part of the bill that would amend the Dodd-Frank Act.

Number of Dodd-Frank Act Stress Test Economic Scenarios. The bill would also reduce the required number of economic scenarios from three to two, eliminating the middle-of-the-road adverse scenario from the Dodd-Frank Act stress testing framework and leaving the baseline and severely adverse scenarios.

Impact on CCAR? While the changes above technically apply to the Dodd-Frank Act stress testing requirements rather than the Federal Reserve’s CCAR capital planning framework, it is difficult to imagine the Federal Reserve taking a different approach in terms of making corresponding changes to its capital planning regulations.

Community Bank Leverage Ratio. The U.S. banking agencies would be directed to establish via rulemaking a community bank leverage ratio—of tangible equity capital to average total consolidated assets—for qualified depository institutions and depository institution holding companies with total consolidated assets of less than $10 billion. An institution or holding company exceeding the community bank leverage ratio—the calibration of which the bill specifies as being not less than 8% and not more than 10%—would be deemed to meet its otherwise applicable capital requirements, including the leverage ratio and risk-based capital requirements, and, in the case of an insured depository institution, the ratios required to be considered well-capitalized for prompt corrective action purposes.

The bill would also require the U.S. banking agencies (1) to consult with the relevant state banking supervisors in implementing the community bank leverage ratio and (2) to notify the relevant state banking supervisor of any qualifying community bank with respect to its compliance with the community bank leverage ratio.

New Provision on the Capital Treatment of Commercial Real Estate Exposures

The Bipartisan Banking Bill includes a new change relating to the capital treatment of high volatility commercial real estate (HVCRE) exposures, which was not included in earlier versions of the bill.

Currently, the U.S. Basel III capital rules define a category of HVCRE exposures that are subject to a heightened, 150% risk weight for purposes of calculating a banking organization’s risk-based capital requirements. The Bipartisan Banking Bill would define a new category of HVCRE ADC loans and would amend the Federal Deposit Insurance Act to prevent the U.S. banking agencies from applying heightened risk weights to an HVCRE exposure unless the exposure also falls within the definition of an HVCRE ADC loan – effectively creating a specific statutory capital regulation requiring the U.S. banking agencies to align their rules with this definition.

The following table summarizes the definition of an HVCRE exposure under the current U.S. Basel III capital rules, the definition of an HVCRE ADC loan under the Bipartisan Banking Bill, and our initial analysis as to the significant differences between the two definitions:

Current Capital Rules – Defining HVCRE Exposure

Bipartisan Banking Bill – Defining HVCRE ADC Loan

Analysis of Difference

Scope of Definition

HVCRE exposure includes a credit facility that finances or has financed the acquisition, development, or construction (ADC) of real property, subject to the exemptions noted below and the provision regarding the conversion to permanent financing.

HVCRE ADC loan includes a credit facility that:

Is secured by land or improved real property;

Primarily finances, has financed, or refinances the ADC of real property;

Has the purpose of financing the acquisition, development or improvement of real property into income-producing (i.e., commercial) real property; and

Is dependent on future income from or proceeds from the sale of (or the refinancing of) such real property for repayment.

The scope of an HVCRE ADC loan is subject to the exemptions noted below and the provision regarding the reclassification as a non-HVCRE ADC loan.

The Bipartisan Banking Bill’s more granular definition may have the effect of narrowing the scope of credit facilities subject to the heightened, 150% risk weight, as all elements of the definition must be satisfied.

Exemptions

No comparable provision.

Grandfathering. Any loan made prior to January 1, 2015.

January 1, 2015 was the first effective date for non-advanced approaches banking organizations to calculate risk-weighted assets using the standardized approach under the U.S. Basel III capital rules. This exemption would apply to any outstanding credit facility that was made prior to the effective date of the current HVCRE exposure definition.

That finances the acquisition or refinance of or improvements to that property;

If the cash flow being generated by the real property is sufficient to support the debt service and expenses of the real property, in accordance with the institution’s applicable loan underwriting criteria for permanent financings.

This new exemption both sensibly covers ADC projects for which the banking organization would not be taking on any more risk than a typical secured loan and aligns with the existing exemption for a credit facility that has converted to permanent financing, as discussed below.

Would qualify as an investment in community development, under the provision of law that authorizes state member banks to make certain public welfare and community development investments, or as a qualified investment, under the rules implementing the Community Reinvestment Act; and

Is not an ADC loan to certain small businesses or farms.

Community Development.Any credit facility that finances the ADC of real property that would qualify as an investment in community development.

Although the bill’s definition of an “investment in community development” is less specific than that contained in the current U.S. Basel III capital rules, this change is likely immaterial, as the U.S. banking agencies would have the authority to interpret the broader statutory exemption in any implementing rule.

Agricultural. Any credit facility that finances the purchase or development of agricultural land, which includes all land known to be used or usable for agricultural purposes (such as crop and livestock production), provided that:

The valuation of the agricultural land is based on its value for agricultural purposes; and

The valuation does not take into consideration any potential use of the land for nonagricultural commercial development or residential development

Agricultural. Any credit facility that finances the ADC of agricultural land.

As with the community development exemption, the HVCRE ADC loan definition would remove the specific requirements for the agricultural land exemption. It remains to be seen, however, how the U.S. banking agencies would interpret this broader statutory definition in any implementing rule.

The Bipartisan Banking Bill version of this exemption would allow the promoter or sponsor of a qualifying project to extract internally generated capital from the project prior to the project’s reclassification as a non-HVCRE ADC loan.

In a potentially significant modification, the bill version would apparently allow the promoter or sponsor to count the value of contributed real property or improvements at the time of the contribution (i.e., inclusive of any change in value since acquisition) towards the 15% contribution threshold, whereas under the existing rules and the U.S. banking agencies’ FAQs regarding these rules (see this FDIC FAQ, Federal Reserve SR Letter 15-06andthis OCC FAQ) contributed real property counts towards the 15% threshold only to the extent it was purchased with cash. Under these FAQs, real estate subject to a mortgage does not qualify as value contributed to a project.

The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio as determined by the relevant U.S. banking agency;

The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio as determined by the relevant U.S. banking agency;

The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate’s appraised “as completed” value;

The borrower has contributed capital of at least 15 percent of the real property’s appraised “as completed” value to the project in the form of:

Cash;

Unencumbered readily marketable assets;

Paid development expenses out-of-pocket; or

Contributed real property or improvements;

The borrower contributed the minimum amount of capital before the banking organization advances funds under the credit facility; and

The borrower contributed the minimum amount of capital before the banking organization advances funds (other than the advance of a nominal sum made in order to secure the depository institution’s lien against the real property) under the credit facility; and

The contributed capital and any capital internally generated by the project is contractually required to remain in the project until the credit facility is converted to permanent financing, as described below.

The contributed capital is contractually required to remain in the project until the credit facility has been reclassified as a non-HVCRE ADC loan, as described below.

No comparable provision.

The value of any real property contributed by a borrower must be the appraised value of the property as determined under standards prescribed pursuant to FIRREA.

Conversion to Permanent Financing

A credit facility ceases to be an HVCRE exposure if it is converted to permanent financing.

Permanent financing may be provided by the banking organization that provided the ADC facility as long as the permanent financing is subject to the Board-regulated institution’s underwriting criteria for long-term mortgage loans.

A banking organization may reclassify a credit facility as a non-HVCRE ADC loan – at which point it no longer may be subject to heightened risk-based capital requirements – upon:

The substantial completion of the development or construction of the underlying property; and

Cash flow being generated by the property is sufficient to support the debt service and expenses of the property, in accordance with the banking organization’s applicable loan underwriting criteria for permanent financings.

The non-HVCRE ADC loan definition provides more guidance as to when an ADC loan transitions to permanent financing, but it would not seem to meaningfully change the existing rules.

This provision of the Bipartisan Banking Bill would effectively prevent the U.S. banking agencies from amending the capital treatment of commercial real estate exposures for non-advanced approaches banking organizations – which they proposed to do in September 2017, as discussed in a prior post here. The bill also clarifies that the U.S. banking agencies would retain their authority to scrutinize all commercial real estate lending in exercising their supervisory functions.